DIFFERENT TYPES OF

MARKET STRUCTURES

Lecture 7
11 July 2014
 What Are Markets?
A market is where buyers and sellers:
– meet to exchange goods and services.
– are affected by some level of competition.

The market may be in one specific place

or
It does not exist physically at all
(IT IS JUST A THEORY!!)
 What Are Markets?
Markets are classified by 4 structures

1. Pure (perfect) Competition

2. Monopolistic Competition

3. Oligopoly

4. Monopoly
 1. Perfect Competition
BEFORE WE BEGIN!!

This is a theoretical situation.

NO TRUE Perfectly Competitive Market
exists.

IT IS ONLY A THEORY!
The 5 conditions of perfect competition
1) LARGE number of SMALL firms.
No single buyer or seller can influence the price.

2) Buyers and sellers deal in identical products. No product

differences. (EXAMPLES: Salt, Flour, Corn)

3) Unlimited Competition: so many firms, that suppliers lose

the ability to set their own price.

4) No Barriers to Entry. Sellers are free to enter the market,

conduct business and free to leave the market. (Low
cost to enter)

5) Each firm is a PRICE-TAKER (more on this later)

CONSUMERS HAVE THE LARGEST SELECTION OF BUYERS TO BUY GOODS
FROM BECAUSE NO SINGLE GOOD IS MORE APPEALING THAN ANOTHER.
The 5 conditions of perfect competition
4) No Barriers to entry. Sellers are free to enter the market,
conduct business and free to leave the market.

Perfect competition is the opposite of monopoly.

Here, any firm can get into the market at very little cost.

 Suppose there was a market for dandelions.

Growing dandelions requires little start-up cost.
 All you need are dandelion seeds, soil, water,
and some sunlight.
 There is no difference between one dandelion
and another, so the market has a similar
product. The agricultural market is the best example
of a perfectly competitive market.
 Perfect Competition
 Each individual firm is too small
to influence prices.
 Price becomes fixed to everyone in the industry.

EXAMPLE: the price of wheat is set only by the

interaction of supply and demand.
Generally speaking, wheat is the
same per ton in Dinajpur as it is in
Chittagong.
 Perfect Competition
Firms in a perfectly competitive market are
price takers. (they take the price they are given, they
can’t change the price)

Since they have no control over their own

NO MARKET POWER
prices, they have _______________________.
MARKET POWER = “the ability to set one’s OWN prices”

 In other words, no one will buy an overpriced

dandelion. Why should they?
 A 4-cent dandelion is the same as the 3-cent one,
so there is no reason to spend that extra penny.
 Monopolistic Competition
The 5 conditions of Monopolistic Competition
1) LARGE number of large companies (but fewer than perfect
competition).
Sellers can influence the price through creating a product identity
(more on this later)

2) Products are NOT exactly identical, BUT VERY SIMILAR,

so companies use PRODUCT DIFFERENTIATION

3) Heavy Competition: Firms must remain aware of their

competitor’s actions, but they each have some ability to
control their own prices.

4) Low Barriers to Entry: harder to get started because of the

amount of competition.
 Monopolistic Competitive Market
STUDY TIP:
The key idea to understanding monopolistic competition is that
firms sell products that are similar, but not exactly alike.

EXAMPLE: Hand Soap

 Essentially, all hand soaps are the same. Yet firms

can create a brand identity that separates their
hand soap from their competitor’s.
 This brand identity can be formed through
packaging, product support, and especially
advertising.
 If effective, consumers will positively identify a
certain brand and purchase it even if hand soap
costs more.
Conditions of Monopolistic Competition
The point is that firms in Monopolistic Competition must
use Product Differentiation & Non-price Competition to
sell their products.

Product Differentiation:
 The real or imagined differences
between competing products in the
same industry.
 Differences may be real or imagined.

 Differentiation may be color, packaging,

delivery, service….. anything to make it stand
out!
Conditions of Monopolistic Competition
The point is that firms in Monopolistic Competition must
use Product Differentiation & Non-price Competition to
sell their products.

Non-Price Competition:
 Non-Price Competition involves the advertising of a
product's appearance, quality, or design, rather than its
price.
 Advertising to help the consumer believe that this product
is different and worth more money.

Notice these
commercials never
VS price.
mention
Examples of Monopolistic Competition

Auto, Steel, Gas, Fast Food, Airlines.

 MERGERS OF LARGE COMPANIES
 Sometimes companies fall victim to market failure. However,
not all businesses close their doors and empty their factories
and stores.
 Many get “swallowed up” by another company. This “take-
over” or acquisition of a company is known as a merger.

There are THREE types of mergers: HORIZONTAL, VERTICAL, and

CONGLOMERATE.
1.) HORIZONTAL: involve firms in the SAME market, such as between two oil
companies.
Reason: Diversification

2.) VERTICAL: involve one firm buying a resource provider.

EXAMPLE: steel company buys an automaker

3.) CONGLOMERATE: a company buys a business in a

UNRELATED industry.
 What is an Oligopoly?
A market in which a two-three large sellers control
most of the production of a good or service and they
work together on setting prices.
Conditions of an Oligopoly
1) Very few Sellers that control the entire market.
2) Products may be differentiated or identical (but
they are usually standardized)
3) Medium barriers to entry: Difficult to Enter the
market because the competitors work together
to control all the resources & prices.
4) The actions of one affects all the producers.
5) Collusion = an agreement to act together or
behave in a cooperative manner.
 What is an Oligopoly?
A market in which a two-three large sellers control
most of the production of a good or service and they
work together on setting prices.

Conditions of Oligopoly
5) Collusion = an agreement to act together or
behave in a cooperative manner.
 Collusion Agreements: usually illegal, among
producers to fix prices, limit output, or divide markets.
(hard to prove that a group of companies is doing this)
 It is also called Price Fixing: setting the same
prices across the industry.
Basically, the companies are acting a one large
monopoly.
 Price Behavior in Oligopoly
Now, sometimes businesses do not agree with each other about the
price, and if that happens, a War will result.

Price Wars: Series of price cuts that competitors must

follow or lose business.
 it is a fierce price competition between sellers, sometimes
the price is lower than the cost of production.
Why is that bad???

 Oligopolists would like to be Independent Price setters:

 a firm sets prices based on demand, cost of input
and other factors (not based on other companies prices).
2 Types of Price Behavior in an Oligopoly

Price Leader: independent pricing decisions made by

a dominate firm on a regular basis that results in
generally uniform industry-wide prices.
ADVANTAGE: you are the company leading the price.

Independent Pricing: policy by a competitor that

ignores other producer’s prices.

DISADVANTAGE: other firms shut you down by

agreeing to set lower prices than yours.
 Conditions of Monopoly
Exact Opposite of Pure Competition.
 A price maker. (set their own price, without regard to
supply and demand)

There is a single seller

No close substitute goods are available

High Barriers to Entry: Other sellers

cannot enter the Market.
 Types of Monopolies
4 Distinct Types of Monopolies:

1) Natural Monopoly: Where costs are minimized by

having a single producer of the product.
Gas, water, electricity: government creates Natural
Monopolies by Franchising some utilities.
 Franchise - the right to produce or do business in a certain
area without competition.
 Government franchises come with government regulation.

WHY WOULD GOVERNMENT DO THIS???

Economies of Scale: As natural monopolies grow larger, this reduces its

production costs (economies of scale).
Because normally companies become more efficient as
the firm becomes larger.
 Types of Monopolies

2) Geographic Monopoly: The only business in

a location due to size of market.
 Decreasing because of mobility.

EXAMPLE: Only
person selling
water in the
desert.
 Types of Monopolies

3) Technological Monopoly:Firm has

discovered a new process or product.
Constitution gave government the right to grant
technological monopolies.
 Patent: 16 years exclusive rights to a developed
technology.
 Copyright: (Artists and writers) Life plus 60 years.
 Types of Monopolies

4) Government Monopoly: Retained by the

government.
 Liquor sales in some counties, uranium
production, water, etc.
3 Conditions of Efficient & Successful
Markets
Markets work best when three conditions are
met:
1) Adequate competition must exist in all
markets.
2) Buyers and sellers are reasonably well-
informed about conditions and
opportunities.
3) Resources must be free to move from one
industry to another.

Market Failure occurs when any of the 3

conditions alter significantly.
 Types & Causes for Market Failure
1) Inadequate Competition: Dangers to monopolies
 Monopolies may waste and misallocate scarce
resources because there is no competition.
2) Inadequate Information: A free enterprise economy
requires information.
 It is difficult to employ resources for the fullest benefit of
society without adequate information.
3) Resource Immobility: The efficient allocation or resources
require that land, labor, capital and entrepreneurs be free to move
to markets where returns are the highest
4) Externalities / Side Effects: A side effect that benefits or harms
a third party that was not directly involved in the activity.
 Negative Externality: People are harmed or inconvenienced
by an economic decision.
 The Role of Government

Government has the power to maintain competition,

regulate monopolies, or to run government-owned
monopolies.

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THANKS